Franco – German plans for a rump euro beginning

A senior EU official said changing the make-up of the euro zone has been discussed on an "intellectual" level but had not moved to operational or technical discussions, while a French government source said there was no such project in the works.

Such steps are also opposed by many EU countries, whose backing would be needed for any adjustments to the bloc’s treaties, making them anything but a done deal.

"This will unravel everything our forebears have painstakingly built up and repudiate all that they stood for in the past sixty years," one EU diplomat told Reuters. "This is not about a two-speed Europe, we already have that. This will redraw the map geopolitically and give rise to new tensions. It could truly be the end of Europe as we know it."

It’s about time. I have been saying for some time that the euro zone is coming apart at the seams. This makes a lot of sense. The question is how to do it. Here’s my suggestion from a few days ago:

The ECB’s backstopping Italy and Spain for fear of German and Dutch banks’ insolvency is like the Fed’s backstopping California and New York for fear of Bank of America, Wells Fargo, Citigroup and JPMorgan Chase’s insolvency. It is not a very palatable solution longer-term. Therefore, in the medium-term, the euro area will move to tighter fiscal integration. This may or may not include Eurobonds.

However, not all members will come along for the ride. Angela Merkel, admitting that leaving the euro zone is politically and legally possible during her commentary addressing the Greek referendum in Cannes, has already broken the taboo. Now everyone knows that it is possible to default, leave the euro zone and re-gain competitiveness in a move to a devalued currency. Given the lack of economic harmonisation in the euro area, some euro members will be forced to leave and choose this path. I predict that when Europe moves to change its constitution to include greater fiscal integration, it will also include explicit mechanisms for countries to leave the euro area.

I say the rump should be Austria, France, Germany, the Netherlands, and Luxembourg. The Belgians are the real problem.

Eventually ERM became the Euro with the Euro’s treaty terms being set in Maastricht in 1992. The problem, at the time, was Belgium. See, the Germans wanted the Belgians in on the currency union. A core of the Benelux states of Belgium, the Netherlands, and Luxembourg along with France and Germany would have suited the Germans just fine.

But, the Belgians had a huge amount of debt – over 100% of GDP. That was a problem, particularly because it allowed the unstable Italians an entree into Euroland. The Germans looked at the Italian Lira as a soft currency and wanted no part of a currency union with the Italians. The Italians seemed to have a different governing coalition almost every year. They were completely incapable of reining in spending and had a weak currency as a result. However, Italy was a founding member of the EU. So, once you let the Belgians in, with their huge debt to GDP burdens, you had to let the Italians in too.

And, once you let the Italians in, well, you had to let in the Spaniards, Portuguese, Greeks and pretty much everyone else.

So, if you have a rump euro, France and Germany need to decide which of the smaller satellite countries get in (Finland, Estonia, Slovenia, Slovakia, Ireland, etc) and whether Belgium is included because the goal is to not have a stable currency union and, I’m sorry, Belgium’s finances and governance are a mess.

P.S. – I’m sure Merkozy will deny these rumours. But they are out there for a reason. the euro is dead and it’s time to prepare for the next stage of the European experiment. First, let’s get ourselves out of this mess though and then we can look to the future.

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty five years of business experience. He has also been a regular economic and financial commentator in print and on television for the past decade. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College.

It would seem as though Malta might also have to leave the Euro as it would be difficult to compete with all our neighbors devaluing. Although a non default transition might not be as painful as the bureaucrats and banks make it out to be.

Mike

ozajh says 7 years ago

Looking on from the other side of the World, it would seem that some of the “smaller satellite countries” have already gone through IMMENSE pain, specifically to qualify for Euro zone membership.

I could imagine both the politicians and the general population in these countries being genuinely enraged (with justification!) if they were now suddenly excluded because of trouble elsewhere.

David Lazarus says 7 years ago

Yes and if they went through austerity as well then I doubt that they will re-elect the politicians that put them through that for nothing.

Jose says 7 years ago

Why keep a rump euro? If this were to happen, the remaining members would still have the problem of absence of a central bank and lender of last resort per country. The ECB of a rump eurozone would soon create the same problems that are leading now to the possible demise of the EMU as it is.

In case the eurozone ends up disintegrating perhaps it would be better for Germany to simply reintroduce the D mark. Then the countries with a strong current account position could voluntarily peg their new currencies to the new mark. Say, Finland, Austria, Holland, Luxemburg and France (even though it is not really a “strong” country, France would have to keep its ties to the mark for political reasons, since the Franco-German axis would probably remain as the core of Europe).

The countries in the D mark peg would benefit from a low inflation rate as a result of a strong currency.

And the remaining nations of today’s eurozone would regain competitiveness via weaker currencies and quickly reduce their public debt to GDP ratio – thanks to not only an improved external balance but also renewed growth (once freed from the austerity packages) and moderate inflation.

Bottom line: if the euro proves not to be able to withstand the present pressure it would be better for the stability of the new system if each of its members seizes the opportunity to recover monetary sovereignty.

edp says 7 years ago

Perhaps in error…it would be my understanding that those out of the “rump’ euro would have their own Central Bank and be able to devalue “adjust” their currency as needed. I am not sure what country out of the “rump” Euro would want to peg their currency to the D Mark. That is a de facto give up of your own central bank independence. In my mind, if the Euro arrangement was most beneficial to Germany in giving them a “captive” export market then a new D mark and its valuation causes a huge problem in Germany’s export abilities….they have a “value” currency and not a “transaction” currency. They would have to devalue to remain globally world competitive. As far as a Greece, Italy or Spain……..I think in the end they would be Ok. No one I know goes to Germany for a vacation….they all go to “perifery” for the sun, the wine and the food….

Dave Holden says 7 years ago

For political reasons I see a breakup as the only option but have you ever tried to push toothpaste back into to the tube?

DiSc says 7 years ago

While fantasizing about new possible monetary setups, I somehow always end up thinking that France, Italy and Spain would end up being in the same bloc. France just lent too much money to the other two, so if either Spain or Italy were to leave the Euro and/or default, that would be the end of France. On the other hand, Germany could buffer the losses of an Italian default, although that would not be pretty of course. Am I wrong?
Then the latin countries could found their own currency with a real central bank and higher inflation targets, something stronger than the lira but weaker than the DM – say a super-Franc – devalue, inflate and kick the shit out of the German balance of payments.

David Lazarus says 7 years ago

Yes but could Germany afford the losses of Ireland, France, Italy, Greece and Spain? Let alone the rest of their non core lending. It also ignores the fact that Austria has significant problems in its banks, with loans to eastern Europe, so would Germany bail out Austria?

As for the periphery having their own currency, I doubt that would work unless they gave up sovereignty and create the institutions that plague the EZ now?